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How to regulate a market-driven roll of smart meters? A multi-sided market perspective Presentation at the 30th USAEE/IAEE North American conference Jan Schächtele1 Jens Uhlenbrock1 10.10.2011 1 EBS Universität für Wirtschaft und Recht i. Gr. Contents ▪ ▪ ▪ Common understanding Smart meter as multi-sided market Market structure analysis Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 2 Some clarifications to understand the focus of our research Essential key terms Electricity meter We are, however, aware that some types of smart meters can also measure natural gas and water consumption but our focus is on electricity Residential and small commercial consumers Large commercial consumers usually face different incentive structures and are in large parts already equipped with meters allowing real-time pricing Market-driven rollout The discourse about state-mandated vs. market-driven rollout is yet undecided. We purposefully do not analyze or make any judgment, but assume a market-driven rollout Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 3 How do we define the smart meter market in our paper EUROPEAN PERSPECTIVE Stakeholder interactions in the electricity market Electricity Cash Information Retailer Consumer Smart devices Power generator DSO* AMI operator ** Key stakeholders * Distribution system operator ** AMI= Advanced meter infrastructure – a system that meters and stores electricity consumption in short time intervals and communicates this information to a central data collection point from which it is also capable of receiving data SOURCE: Own analysis Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 4 In many cases incentives to install a smart meter are not strong enough for a single investor – this is the challenge to tackle Cost benefit comparison ILLUSTRATIVE EXAMPLE FOR EUROPE Yearly benefits in EUR/meter* Yearly cost in EUR/meter* 45 40 35 30 25 20 15 10 5 0 DSO AMI operator Retailer Consumer Investor in meter * In order to convert £ to €, an exchange rate of 1.1659 (average of 2010) is assumed. SOURCE: Nabe et al. (2010); Mott MacDonald (2007); A.T. Kearny (2008) Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 5 The goal of our research is twofold – identification and assessment Focus and goal of the paper Focus Systematically analyze how to best regulate the smart meter market assuming the regulator favors a market-driven rollout ▪ Demonstrate that the smart meter market is multi-sided for Goal ▪ every possible market structure Identify the superior market structure to overcome the investment barrier – based on the gained insights Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 6 Contents ▪ ▪ ▪ Common understanding Smart meter as multi-sided market Market structure analysis Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 7 AMI meets the requirements of a multi-sided market Definition of a multi-sided market Key stakeholders AMI Defining properties Cash Electricity Information Retailer DSO Consumer AMI operator Status At least two types of distinct users – potentially even with different products (Rochet&Tirole 2003, Armstrong 2006) Indirect network effects – based on positive externalities (Armstrong 2006, Evans2009) Failure of Coase theorem (Rochet&Tirole 2002) Performance of min. one core functions (Evans 2009, Haigu 2009) ▪ Shared resource ▪ Matchmakers ▪ Build audience – – Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 8 The economics of multi-sided markets reveal new insights for the pricing Implications of the multi-sidedness of the AMI Lessons from multi-sided market literature ▪ ▪ Chicken-egg-problem – How to get critical mass for start due to positive externalities – Complication through fixed upfront investment Indirect network effects – Benefit transfer between market sides to account for indirect network effects – towards consumers Related considerations ▪ Socialization of AMI cost – Benefits of smart meters are also (partly) socialized – Likely to be an underprovision due to limited market knowledge SOURCE: Armstrong (2006); Evans (2009); Rochet&Tirole (2003); Wright (2003) Implications for pricing Price structure – who pays what relevant Prices do not need to reflect marginal cost In case of smart meter costs for consumers should be lowered Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 9 Contents ▪ ▪ ▪ Common understanding Smart meter as multi-sided market Market structure analysis Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 10 The combined AMI-DSO is best suited for a market-driven smart meter rollout Summary of the evaluation for the three market structures Platform R R C DSO AMI R C DSO AMI C DSO AMI Platform Platform Consumer, DSO Consumer, Retailer, DSO Consumer, Retailer Investment security –– – ++ Socialization of cost 0 –– ++ Benefit transfer for network effects – + ++ ++ 0 + + ++ – + ++ – Market sides Platform operation internalizes benefits Incentive for operating efficiency Incentive for innovation SOURCE: Own analysis Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 11 Key recommendations for a market-driven rollout Essential messages Put the DSO in charge The DSO is the central player to conduct, administer and successfully implement a market-driven smart meter rollout as it best deals with the features of multi-sided markets Apportion investment costs of smart meters Because of positive externalities and the need to lower the investment hurdle for consumers, a part of the costs should be socialized–the investment costs are best suited. Higher operating costs should be paid by consumer These costs should not be socialized, or else there would be no cost control and it would be a full rollout. Define a standard smart meter In order to have some cost control, a standard smart meter has to be defined. Costs above this standard have to be borne by individual consumers. Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 12 Back up Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 13 What makes meters smart? – Above all it is two-way communication Catalogue of potential features ▪ Two-way communication interface for ▫ Energy consumption ▫ Flexible tariffs ▫ Function signals between meter and retailer/DSO ▪ ▪ Interface to Home Area Network (HAN) Electronic meter movement – Energy – Power quality control - voltage monitoring ▪ ▪ ▪ Data storage Remote (dis-)connect Fraud and manipulation detection SOURCE: Bundesnetzagentur (2010), pp. 30-33, Ecofsys, EnCT, BBH (2010) pp. 18-21Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 14 There are further applications building upon AMI Customer applications aiming at demand response ▪ Technical components – In-home displays – Load control devices/Usage aware devices ▪ Price signals – Time-of-use pricing – Critical peak pricing AMI basic (Customer applications aiming at integration) ▪ Storage – electronic vehicles, cells ▪ Distributed generation – renewable energy sources functionality (remote access) Grid applications leveraging the AMI communication infrastructure SOURCE: McKinsey on Smart Grid (2010), Ecofsys, EnCT, BBH (2010) pp. 53-55 Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 15 Each key stakeholder profits in a different way from smart meters Overview of benefits Consumer DSO ▪ ▪ ▪ Monetary aspects – Variable (cheaper) tariffs – Lower energy consumption due to visualization – No estimats for meter reading Qualitative aspects – No appointments for meter reading – Higher product quality ▪ Quality aspects – Detection of outages – Reduction of voltage fluctuation Reduction of process cost – lower maximal grid load – Detection of fraud – No estimates of energy consumption for grid usage fees Retailer (Former) meter operator ▪ ▪ ▪ Reduction of process cost – Better data quality – Interperiod meter reading – Remote deactivation in case of move – Cost advantages for energy purchase Closer customer relationship – better tariff structure – monthly billing ▪ SOURCE: Frontier Economics (2007), Mott Mac Donald (2007), Nabe et al. (2009) Reduction meter reading cost – Only limited personnel required – Lower organisational effort Reduction process cost – Better data quality Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 16 Countries such as Germany favor a market-driven smart meter rollout Pros and cons of a market-driven smart meter rollout Pros ▪ No inflation of cost base – ▪ ▪ Marginal cost of smart meter installation do not outweigh marginal benefits for every consumer Conscious decision by consumer increases changes for adaption of behavior – pure installation has no effect on energy efficiency (OFGEM; Bundesnetzagentur) Lower intervention of regulatory regime required (Baringa) Cons ▪ No security with respect to ▪ ▪ target achievement – neither for time period nor critical mass (Wissner) Missing out cost savings potential – economies of scale, learning curve, street by street rollout (Wissner&Growitsch, Baringa) Underevaluation of savings potential can lead to lower than meaningful rollout level (Wissner&Growitsch) The discourse about state-mandated vs. market-driven rollout is yet undecided. We purposefully do not analyze or make any judgement on this matter, but assume that the regulator favors a market-driven rollout―for whatever reason Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 17 Retailers as AMI platform operators Advantages ▪ Cost pressure for platform operation and incentive for innovations due to competitive retail market ▪ Internalization of retailer benefits through platform operation Cash Electricity Information AMI platform operator Retailer DSO Consumer AMI Disadvantages ▪ Limited socialization of cost – only based on existing customer base ▪ High investment risks as a consequence of competitive retail market ▪ Cost transfer away from consumers difficult – accounting of DSO’s monetary benefits requires regulation Conclusion: The cost pressure on retailers fosters cost efficiency and innovation, but the disregard of two-sided market economics combined with the high investment risk make it unlikely that such a market ever materializes SOURCE: Own analysis Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 18 Independent AMI platform operators Advantages ▪ Cost pressure for platform operation and incentive for innovations due to highly competitive meter market ▪ Cost transfer away from consumers partly possible – indirect network effects of retailers passed on due to competition Cash Electricity Information Retailer DSO Consumer AMI AMI platform operator Disadvantages ▪ No socialization of cost – bearing of full smart meter cost by consumers ▪ Investment risk due to competition in the meter operator market ▪ Cost transfer away from consumers partly possible – accounting of DSO’s monetary benefits requires regulation Conclusion: The competitive environment creates innovation incentives and cost pressure for AMI platform operators, however, the investment risk and the partial disregard of multi-sided market economics may hinder a market driven roll-out SOURCE: Own analysis Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 19 DSOs as AMI platform operators Cash Electricity Information Retailer Consumer AMI DSO Advantages ▪ Possibility for socialization of smart metering costs – if allowed by regulator ▪ High investment security due to monopoly ▪ Cost transfer possible – indirect network effects of retailers passed on due to competition ▪ Internalization of DSO benefits through platform operation Disadvantages ▪ Low incentives for platform efficiency and innovation above regulatory required standards ▪ (Reversal of meter market liberalization) AMI platform operator Conclusion: The market structure allows for taking advantage of the characteristics of two-sided markets which decreases the roll out cost for consumers, but this comes at the expense of a monopoly position for the AMI platform operator SOURCE: Own analysis Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 20 There are four potential design options for the combined grid and AMI platform operator Common base ▪ Socializable cost are defined and recognized by regulatory regime ▪ DSO is in charge for socializable cost and compensated through fees ▪ Consumer with veto power in case of higher cost SOURCE: Own analysis Design options No socialization of cost Text Socialization of operating cost Description ▪ The individual consumer has to bear the full cost of the smart meter - investment and operating cost ▪ The consumer has to bear the investment cost of the smart meter The operating cost of the smart meter are socialized and distributed over all consumers ▪ ▪ Socialization of investment cost ▪ ▪ Total socialization of cost The investment cost of the smart meter are socialized and distributed over all consumers The (increased) operating cost of the smart meter are billed to the individual consumer Both investment and operating cost are socialized and distributed among all consumers Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. | 21